How Much Is Teck Resources Worth?

Oct.11.12 | About: Teck Resources (TCK)

With a market cap of almost $18 billion, Teck Resources Limited (NYSE:TCK) is one of the largest industrial mining companies in Canada. The company has a diversified portfolio of operations. Teck Resources explores, develops and extracts several types of industrial mines including zinc, lead, germanium, indium, cadmium, tin, copper and metal alloys. The company even extracts silver and gold. Formerly known as Teck Cominco Limited, the company changed its name to Teck Resources in 2009. TCK did not perform well this year. Its market cap is reduced by about 11% since January. I think the stock is pretty cheap based on fundamental metrics, and my FED+ model supports this notion.

As of the time of writing, TCK stock was trading at $31 with a 52-week range of $26 - $44. Trailing twelve month P/E ratio is 9.1, and forward P/E ratio is 10.4. P/B, P/S, and P/CF ratios stand at 1.0, 1.6, and 4.5, respectively. The 3-year annualized revenue and EPS growth stand at 20.1% and 45.2%, respectively. Operating margin is 33.9%, and net profit margin is 16.9%. The company has a debt-to-equity ratio of 0.4. TCK pays decent dividends. Based on the most recent quarterly dividend of 40 cents, the stock has a projected yield of 2.56%.

TCK has a 4-star rating from Morningstar. While its trailing P/E ratio is 9.1, it has a 5-year average P/E ratio of 10.4. Thus, TCK is trading below its historical P/E ratio. Out of 16 analysts covering the company, 10 have hold, 3 have outperform and 3 have hold ratings. Wall Street has diverse opinions on TCK's future. The bottom line is -4.7% growth, whereas the top-line growth estimate is 35.6% for the next year. Average five-year annualized growth forecast estimate is 6.4%.

What is the fair value of TCK given the forecast estimates? We can estimate TCK's fair value using discounted earnings plus equity model as follows.

Discounted Earnings Plus Equity Model

This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:

V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value

V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]

The earnings after the last period act as a perpetuity that creates regular earnings:

Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r

While this formula might look intimidating for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.

Valuation

Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year.

E0 = EPS = ($3.34 + $2.99) / 2 = $3.17

Wall Street holds diversified opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 6.3%. Book value per share is $31.32.

The rest is as follows:

Fair Value Estimator

V (t=0)

E0

$3.17

V (t=1)

E0 (1+g)/(1+r)

$3.03

V (t=2)

E0((1+g)/(1+r))2

$2.90

V (t=3)

E0((1+g)/(1+r))3

$2.78

V (t=4)

E0((1+g)/(1+r))4

$2.66

V (t=5)

E0((1+g)/(1+r))5

$2.55

Disposal Value

E0(1+g)5/[r(1+r)5]

$23.28

Book Value

BV

$31.32

Fair Value Range

Lower Boundary

$49

Upper Boundary

$72

Lower Potential

30%

Upper Potential

130%

Click to enlarge

(You can download FED+ Fair Value Estimator, here.)

I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for TCK is between $49 and $72 per share. At the current valuation, the stock is trading significantly below its fair value range. It has at least 30% upside potential to reach its fair value.

Competition

While there are many companies in the diversified industrial mining sector, BHP Billiton (NYSE:BHP), Vale (NYSE:VALE), and Rio Tinto (NYSE:RIO) are the largest competitors of TCK Resources.

TCK Resources

BHP Billiton

Vale

Rio Tinto

Trailing P/E

9.1

11.9

5.95

21.99

Forward P/E

10.4

12.1

6.48

6.64

P/B

1

1.67

1.17

1.63

Trailing Yield

2.51%

3.26%

3.22%

3.36%

Debt/Equity

0.1

0.43

0.34

0.38

Click to enlarge

Based on the trailing and forward P/E ratios, Vale is the cheapest one among this group. Vale's single digit P/E ratio is one of the lowest in the diversified mining field. I think Vale is trading at a deep discount, but the uncertainty of Brazil's business environment creates a strong pressure on the stock.

Rio Tinto is another global diversified mining giant. Its stock trades in London, NYSE, and also Australian Securities Exchange. Its activities are mostly concentrated in Australia and North America. Rio also looks cheap based on the forward earnings.

With a market cap of more than $180 billion, BHP Billiton is the largest diversified mining company in the world. The company is trading at a relative premium over the book value. Its D/E ratio is also higher than the peers.

Recent Events

At the beginning of the month, Deutsche Bank adjusted its target price for Teck Resources to $31. The previous target price was $37. Deutsche Bank maintained a hold rating on the stock.

Most recently, Alcoa (NYSE:AA) reported its third quarter earnings. The company beat the analyst estimates, but the management cut the expectations for the next year. The warning signs on lower aluminum demand initiated a loss of confidence on Alcoa investors. Alcoa lost about 4% the day after the earnings announcement. While Alcoa does not directly compete with TCK Resources, the demands for industrial mines are highly correlated with each other. Chinese subsidies to its local mining firms continue to be a big challenge for all international mining companies.

Summary

Unlike Deutsche Bank, I think TCK is one of the cheapest stocks among its peers. Its dividends are totally safe. There is even a potential for dividend growth in the future. The industry is highly volatile, and there are several factors that affect the company's profitability. The slow growth in global demand and rising competition from Chinese producers are the current challenges.

Nevertheless, if analysts' estimates hold, TCK could be an outperformer. The company has shown double digit growth rates in the recent years, and a modest growth rate of 6.3% seems to be a feasible one. Based on this growth estimate, my FED+ valuation suggests at least 30% upside potential. Analysts also agree with me. Their target price of $48.5 matches almost perfectly with my minimum fair value estimate.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.